Demand side factors are certainly playing a role. James Hamilton from Econbrowser estimates that dollar strength, global macro weakness as proxied for by copper prices, and the decline in 10 year rates explains around 44% of the fall in crude prices since July.

That leaves around half of the decline unexplained. By definition, if it’s not coming from the demand side it must be from demand. Many analysts have talked about fracking and the growth in tight oil in the United States as a major factor. But there’s two reasons to be skeptical.

First, increasing tight oil production has been a long time coming. That should have easily been priced in.

Second, more sober analyses of the expansion in US oil production that suggest that much of the hype surrounding US oil production substantially changing global prices is overrated. There’s just not enough oil of the right blends to be making such a huge impact on global markets.

In my view, any plausible story for the recent decline in oil prices has to explain why recent small shocks about the future state of the world can translate into such dramatic price moves today.

One possibility comes from a story about the OPEC put. OPEC’s announcement in November wasn’t just about not cutting production, but rather it represented a regime change about how OPEC would respond to lower prices. One way to think about it is that OPEC’s previous policy of cutting production at low prices functioned as a put option on oil. No matter what, there would be a price floor.

But now that put option is out of the window. Without it, the left tail in oil prices exerts an effect on the current price. This can happen in at least two ways. As a first order effect, people with oil stocks sell at expected value, and when the low price events become possibilities, you sell at a lower price. But there’s also an effect on storage. By removing the put option, OPEC raises the specter of highly volatile and potentially very low oil prices in all future periods. This makes oil much less worthwhile to store, and as such producers will flood the current market with their stocks.

The formalism resembles a Hotelling model in which speculators store oil only if the expected return is competitive with other market interest rates + a risk premium. Given that rates are so low, variance in the risk premium matters more. If we think that the states of the world with extremely low oil prices are “expensive risk” states of the world (because macro conditions are bad), then these risks should now play a powerful role in inducing drawdowns in oil stocks.